House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 9 - Financial statements for Australian permanent establishments

Outline of chapter

9.1 This chapter explains the requirement for some foreign entities investing in Australia to prepare financial statements that comply with the accounting standards. These requirements are contained in Subdivision 820-L.

9.2 These rules will apply to an income year that begins on or after 1 July 2002. [Schedule 1, item 22, section 820-10]

Context of reform

9.3 Special record keeping requirements will be imposed on certain non-resident entities that carry on business at or through a permanent establishment in Australia (e.g. a branch). This bill refers to these entities as inward investors. These entities will be required to keep financial statements, which have been prepared in accordance with Australian accounting standards, for their permanent establishments. The information in these statements will assist administration of the income tax laws, especially in the application of the thin capitalisation rules. Currently non-residents with Australian permanent establishments do not have to prepare such statements.

9.4 The requirement to prepare financial statements for permanent establishments is broadly consistent with Recommendation 22.11(c) contained in A Tax System Redesigned.

9.5 The separate financial statements for permanent establishments are to be prepared on the basis of the assets, liabilities, equity, revenue and expenses which are attributable to the permanent establishment. In preparing financial statements consideration should be given to the functions performed, assets used and risks borne by the permanent establishment. This would include amounts arising from notional transactions that must be recognised under the foreign bank branch provisions contained in Part IIIB of the ITAA 1936.

Summary of new law

9.6 Inward investors carrying on business in Australia at or through a permanent establishment will:

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need to prepare separate financial statements for their permanent establishments;

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need to prepare those statements in accordance with the accounting standards; and

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be liable for a penalty if they fail to comply with these requirements.

Detailed explanation of new law

Which entities are required to prepare financial statements?

9.7 The record keeping requirements will be imposed on the following entities where they carry on business at or through one or more Australian permanent establishments:

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general inward investors;

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financial inward investors; and

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ADI inward investing entities.

[Schedule 1, item 1, section 820-960]

9.8 The term Australian permanent establishment is defined as a permanent establishment in Australia at or through which an entity carries on business [Schedule 2, item 17, definition of Australian permanent establishment in subsection 995-1(1)] . An example of an Australian permanent establishment is a foreign bank branch in Sydney or Melbourne.

What financial statements need to be kept?

9.9 Entities will be required to keep:

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a statement of financial position ; and

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a statement of financial performance .

[Schedule 1, item 1, subsection 820-960(1)]

9.10 The terms statement of financial position and statement of financial performance have the meaning as given in the accounting standards and include all the notes required to accompany these statements. [Schedule 1, item 1, subsection 820-960(3)]

What accounting standards are relevant?

9.11 For thin capitalisation purposes, the relevant accounting standards are those made by the AASB. [Schedule 1, item 1, section 820-960; Schedule 2, item 2, definition of accounting standards in subsection 995-1(1)]

9.12 Currently, the AASB accounting standards define a statement of financial performance as the profit and loss statement required by Corporations Law . Similarly, they define a statement of financial position as the balance sheet required by the Corporations Law . Specific requirements as to the content and form of the statements are contained in the accounting standards.

9.13 Entities will be required to comply with all the accounting standards in preparing financial statements for their Australian permanent establishments. Three accounting standards have been specifically listed in the legislation as they are of particular relevance. [Schedule 1, item 1, paragraph 820-960(2)(b)]

9.14 Two standards directly relate to the content and form of the financial statements. These are:

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AASB 1018: Statement of Financial Performance , which prescribes the presentation and disclosure requirements for the statement of financial performance and recognised revenues, expenses and valuation adjustments; and

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AASB 1040: Statement of Financial Position which prescribes:

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the basis for the presentation of assets and liabilities;

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the basis for the classification of assets, liabilities and items of equity; and

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presentation and disclosure requirements for the statement of financial position, and recognised assets, liabilities and items of equity.

9.15 The third accounting standard, AASB 1001: Accounting Policies , prescribes the concepts that guide the selection, application and disclosure of accounting policies. The standard requires specific disclosures to be made in relation to the accounting policies adopted in the preparation and presentation of the financial report. Importantly, at paragraph 4.1.2, AASB 1001 provides guidance for selecting an appropriate accounting policy in the absence of a specific accounting standard, other authoritative pronouncements or Urgent Issues Group Consensus Views. It should be noted that the AASB may issue or revise the relevant accounting standards from time to time.

Scope of the reporting requirements

9.16 In order to define the parameters for which the entity is required to prepare financial statements, the legislation creates a notional entity which comprises the entitys Australian permanent establishments. The statement of financial position and statement of financial performance must be prepared in accordance with the accounting standards as if:

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the notional entity were an entity for which these statements would be required to be prepared under the accounting standards;

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the assets, liabilities and equity that are attributable to the Australian permanent establishments were the notional entitys assets, liabilities and equity;

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the revenues and expenses that are attributable to the Australian permanent establishments were the notional entitys revenues and expenses; and

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a reference to a financial year in the accounting standards were a reference to an income year.

[Schedule 1, item 1, paragraph 820-960(2)(b)]

9.17 Therefore, it will be necessary for entities to undertake an analysis of the functions performed, the assets used and risks borne by their Australian permanent establishments in order to determine the assets, liabilities, equity, revenue and expense which should be attributed to the notional entity.

Timing

9.18 Entities will be required to prepare the financial statements before they lodge their income tax returns for a year of income beginning on or after 1 July 2002. [Schedule 1, item 1, subsection 820-960(2) and item 22, subsection 820-10(2)]

The Commissioners power

9.19 To ensure that inward investors are not subject to unnecessary compliance costs, the Commissioner may decide that an entity is not required to comply with an accounting standard or part of a standard. The Commissioner must be satisfied that it would be unreasonable that the entity be required to do so and the decision must be provided in writing [Schedule 1, item 1, subsections 820-960(4) and (5)] . It is envisaged that when this power is exercised the Commissioner will issue a taxation ruling advising entities accordingly.

9.20 A person who is dissatisfied with a decision by the Commissioner in exercising this power may object against the decision under Part IVC of the TAA 1953. [Schedule 1, item 1, section 820-965]

Failure to keep financial statements

9.21 The record keeping requirements imposed by Subdivision 820-L are incorporated into the general record keeping provision (section 262A) of the ITAA 1936 [Schedule 1, items 10 and 11 (consequential amendments to section 262A)] . As a consequence, failure to comply with the requirements will render a person liable to prosecution under section 262A or an administrative penalty under section 288-25 of Schedule 1 to the TAA 1953. The penalty units are 30 and 20 respectively.

9.22 The record keeping requirements in Subdivision 820-L and section 262A as well as the prosecution and offence provisions in Part III of the TAA 1953 will apply to partnerships and unincorporated companies as if these entities were persons. [Schedule 1, item 1, sections 820-990 and 820-995]

Application and transitional provisions

9.23 This measure does not commence until an income year beginning on or after 1 July 2002. [Schedule 1, item 22, subsection 820-10(2)]

Consequential amendments

9.24 A consequential amendment is made to section 262A to bring the record keeping requirements in Subdivision 820-L within that provision. [Schedule 1, items 10 and 11]